By Bryan Koenig
Law360, Washington (June 29, 2017, 7:43 PM EDT) -- Harvard’s legal clinic for low-income taxpayers waded into a tax shelter promoter’s Second Circuit appeal of a $160 million IRS penalty on Wednesday, arguing in an amicus brief that a lower court ruling tossing his penalty challenge means that many poor taxpayers won't be able to contest their own liabilities in court.
The Legal Services Center of Harvard Law School Federal Tax Clinic is ostensibly supporting the appeal from John Larson, who was convicted in 2009 of crimes relating to the creation and implementation of fraudulent tax shelter vehicles. But the clinic’s real concern is U.S. District Judge Valerie E. Caproni’s late December decision finding no jurisdiction to hear Larson’s appeal because he did not pay all the outstanding tax and penalties, of which about $67 million remains.
Larson had to pay up first because he’s facing “assessable penalties” under Section 6671 of the U.S. Code, which, according to the amicus brief, covers some 50 different kinds of penalties whose imposition requires taxpayers to pony up the full amount and then sue for a refund, prohibiting any pre-payment challenge in Tax Court.
The bar comes from U.S. Supreme Court rulings in 1958 and 1960 in Flora v. United States whose modern application, in what the clinic describes as a “crusade” on tax shelter promoters, has unintentionally ensnared poor taxpayers also facing some kind of assessable penalty, according to the brief.
“The impact of the decision below effectively bars taxpayers with an assessable penalty from any opportunity to challenge their liability in court. When it adopted the full payment rule, the Flora court noted that poor taxpayers would still have the opportunity to challenge their liability in the Tax Court prior to payment,” the clinic said Wednesday.
“But the court did not foresee the current assessable penalty regime, in which taxpayers are regularly shut out of the Tax Court,” the clinic continued. “Were Flora decided fifty years later, we believe that the court would have restricted the full payment requirement to those taxpayers who had the option of prepayment litigation in the Tax Court.”
While Congress has tried to create administrative routes to help taxpayers challenge their Internal Revenue Service liabilities, those moves have still not translated to available court remedies, the clinic said, pointing to how the tax agency has interpreted collection due process, or CDP, hearings, along with rulings out of the Fourth, Seventh and Tenth Circuits.
“Almost no taxpayer” is able to pay multimillion-dollar liabilities upfront, the clinic said.
“But even a modest amount of assessable penalty is a barrier to low-income taxpayers. Often, they are unable to pay even a $1000 penalty,” the clinic said. “Because CDP is not the safety valve for these taxpayers that Congress intended, we urge this court to reevaluate its application of the Flora full payment rule.”
An attorney for Larson welcomed the amicus brief on Thursday.
Megan L. Brackney of Kostelanetz & Fink LLP said the brief is helpful to her client’s case, an appeal built around the “inescapable paradox” in which he’s been placed that makes the government’s “overwhelming penalty” beyond his ability to challenge. Larson contends that the court’s finding, along with its conclusion that he can’t employ Administrative Procedure Act review because he already has an available remedy via court refund claim, amounts to “an axiomatic affront to due process.”
Brackney told Law360 that the lower court’s jurisdictional view affects all kinds of taxpayers at all financial levels of potential penalty. The amicus brief, she said, ideally will raise the case’s profile in the circuit’s eyes as it considers the wider ramifications.
Counsel for the clinic did not immediately respond late Thursday to a request for comment. The IRS does not comment on litigation.
According to Larson’s January 2016 complaint, the IRS had told him in February 2003 that he was under examination, and the agency followed up with a letter in February 2011 asserting that he was a tax shelter organizer and had failed to register transactions, subjecting him to penalties.
After receiving a letter notifying him of the proposed $160 million in penalties, Larson filed a request for reconsideration of the proposed fine and an appeal of the findings of the IRS examination. In August 2011, while the appeal was underway, the agency sent him an assessment notice for the full amount it had proposed.
In December 2012, the agency reduced the penalty against Larson to $67,661,349, conceding that the IRS had not credited him for penalty payments made by co-promoters. He made a payment of more than $1.4 million in February 2015 and argued, unsuccessfully, that his penalties were divisible and thus he could have brought a challenge after making good on a single taxable event.
His complaint says that while the IRS Appeals Office did not provide information about which other penalty payments were applied to reduce his payments, the reduction was based on payments made by law firm Sidley Austin LLP, accounting firm KPMG LLC and Deutsche Bank AG for liability arising from the same transactions at issue in Larson’s case.
Larson is represented by Megan L. Brackney of Kostelanetz & Fink LLP and Reed J. Hollander and C. Wells Hall III of Nelson Mullins Riley & Scarborough LLP.
The clinic is represented by director T. Keith Fogg and by student attorneys David Rubin and Andrew Lu along with the director of the Philip C. Cook Low-Income Taxpayer Clinic, W. Edward Afield, and student attorneys Misty Gann and Neekul Bhakhri.
The government is represented by Andrew Edward Krause of the U.S. Department of Justice.
The case is Larson v. United States of America, case number 17-503 in the U.S. Court of Appeals for the Second Circuit.